European Deposit Insurance Scheme: Mitigating the Moral Hazard Problem

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School of Business | Bachelor's thesis
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Date
2018
Major/Subject
Mcode
Degree programme
Taloustiede
Language
en
Pages
24
Series
Abstract
In this thesis I study moral hazard problem in a deposit insurance scheme based on the existing literature and two economic models. This is a topical issue at the moment as the European banking union aims for deeper convergence between the member states by establishing a common deposit insurance scheme, EDIS. Deposit insurance scheme is useful since it prevents bank runs. However, it increases moral hazard problems which have destabilizing effects on financial markets. I find that there are various ways to mitigate these moral hazard problems. Merton’s (1977) model of risk-based deposit insurance premiums presents a theoretical framework to understand how the moral hazard problem can be alleviated by risk-based pricing. Moreover, appropriate prudential regulation and supervision also lessen moral hazard behavior. Nevertheless, these approaches have their limitations. Specifically, asymmetric information poses problems, and in addition these approaches are costly, and they reduce banks’ competitiveness. Consequently, a balance between costs and benefits needs to be found.
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Thesis advisor
Murto, Pauli
Mustonen, Mikko
Keywords
moral hazard, deposit insurance, risk-based pricing, European Banking Union, capital requirements, asymmetric information, EDIS, explicit insurance
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